The IRS works hard every year to communicate new or prevalent illegal schemes perpetrated by scammers against millions of taxpayers. Last week, the IRS announced its “Dirty Dozen” Top Tax Scams for 2022 with a warning about four financial arrangements that tax authorities have found to be abusive. The IRS urges taxpayers to think twice before putting their money into transactions that could be aggressively promoted scams that are on the IRS’ law enforcement radar screen.
The four potential-scam financial arrangements sound legit; many scams do because they are a twisted version of true scenarios. These transactions are complicated and sophisticated, and they are promoted by slick-sounding “financial advisors”. So, how do you identify “Dirty Dozen” scam transactions that the IRS is warning taxpayers about? Here are some clues:
- Charitable Remainder Annuity Trust (CRAT) Used to Eliminate Taxable Gain
This transaction transfers appreciated property to a CRAT and taxpayers improperly claim the transfer of the appreciated assets. This action gives those assets a step-up in basis to fair market value as if they had been sold to the trust. The CRAT then sells the property but does not recognize a gain due to the claimed step-up in basis. The CRAT then uses the proceeds to purchase a single premium immediate annuity for which the beneficiary misapplies the tax rules by reporting only a small portion of the annuity income.
- Foreign Pension Arrangements Misusing Tax Treaty
U.S. citizens or residents make contributions to certain foreign individual retirement arrangements in a foreign country with a tax treaty to avoid U.S. tax. The individual typically lacks a local connection to the country, and local law allows contributions in a form other than cash or does not limit the amount of contributions. By asserting the foreign arrangement is a “pension fund” for U.S. tax treaty purposes, the U.S. taxpayer improperly claims a tax exemption from U.S. income tax.
- Puerto Rican and Other Foreign Captive Insurance
In these transactions, U.S owners of closely held entities participate in a purported insurance arrangement with a Puerto Rican or other foreign corporation with cell arrangements or segregated asset plans in which the U.S. owner has a financial interest. The U.S.-based individual or entity claims deductions for the cost of “insurance coverage” provided by a fronting carrier, which reinsures the “coverage” with the foreign corporation.
- Monetized Installment Sales
This involves the inappropriate use of the installment sale rules by a seller who, in the year of a sale of property, effectively receives the sales proceeds through purported loans. The seller enters into a contract to sell appreciated property for cash and then purports to sell the same property to an intermediary in return for an installment note. The intermediary then “sells” the property and receives the cash purchase price. In a series of related steps, the seller receives an amount equivalent to the sales price in the form of an unsecured loan.
Don’t get caught by one of the IRS “Dirty Dozen”, including transactions that could be aggressively promoted scams. Read about how to identify and avoid the Top Tax Scams for 2022 at https://www.irs.gov/newsroom/irs-warns-taxpayers-of-dirty-dozen-tax-scams-for-2022.